Builders FirstSource, Inc. (NYSE:BLDR) Shares Could Be 28% Above Their Intrinsic Value Estimate

Key Insights

• Builders FirstSource's estimated fair value is US$141 based on 2 Stage Free Cash Flow to Equity
• Builders FirstSource is estimated to be 28% overvalued based on current share price of US$181
• Our fair value estimate is 23% lower than Builders FirstSource's analyst price target of US$183

Today we will run through one way of estimating the intrinsic value of Builders FirstSource, Inc. (NYSE:BLDR) by taking the forecast future cash flows of the company and discounting them back to today's value. This will be done using the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for Builders FirstSource

The Method

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$1.36b	US$1.54b	US$1.32b	US$1.19b	US$1.12b	US$1.08b	US$1.06b	US$1.05b	US$1.06b	US$1.07b
Growth Rate Estimate Source	Analyst x7	Analyst x5	Est @ -14.72%	Est @ -9.62%	Est @ -6.05%	Est @ -3.55%	Est @ -1.80%	Est @ -0.57%	Est @ 0.29%	Est @ 0.89%
Present Value ($, Millions) Discounted @ 7.9%	US$1.3k	US$1.3k	US$1.0k	US$879	US$766	US$685	US$624	US$575	US$535	US$500

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$8.2b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.3%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 7.9%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$1.1b× (1 + 2.3%) ÷ (7.9%– 2.3%) = US$20b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$20b÷ ( 1 + 7.9%)¹⁰= US$9.2b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$17b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$181, the company appears slightly overvalued at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

Important Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Builders FirstSource as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 7.9%, which is based on a levered beta of 1.211. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

SWOT Analysis for Builders FirstSource

Next Steps:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Why is the intrinsic value lower than the current share price? For Builders FirstSource, there are three essential items you should look at:

1. Risks: Be aware that Builders FirstSource is showing 2 warning signs in our investment analysis , and 1 of those is potentially serious...
2. Future Earnings: How does BLDR's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
3. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.